TWIA report card shows giant error on law

TWIA has just submitted its 2013 report card to the legislature. I hope the House Insurance Committee calls TWIA leaders on the carpet for it.  In addition to exhibiting a “band played on” mentality that fails to note the grave situation facing the organization and its policyholders, it contains a graphic purporting to explain its projected funding that is simply wrong because it reflects a grave misunderstanding of the laws that govern it.

Here’s the graphic.  It is found on page 23 of the annual report.



The problem is the turquoise area.

First, notice a few things.

TWIA has written off the Class 1 bonds.  They do not appear on the graphic.   TWIA has apparently acknowledged that not even one dime of post-event Class 1 Bonds can be sold.  The reason they have done so is that the market does not believe TWIA policyholders and their premium dollars will provide a sustainable basis for repayment of bonds.

TWIA believes it has just $200 million in premiums and its Catastrophe Reserve Trust Fund to pay claims.  This is less than this blog has given TWIA credit for.

TWIA believes, as we suggested earlier, that it will have $1 billion in reinsurance that will attach at $1.7 billion and that the premiums will be $106 million (a little more than we thought).

But now notice the problem.  It’s the turquoise area labeled “$1 billion Class 2 Post Event Bonds.”  Notice the repayment source. “Repaid by Non-Recoupable Assessments to Pool (30%) and Surcharges to Catastrophe Area P & C Policyholders (70%).” This is wrong, wrong, wrong.  This source of bond repayment can not be used under Texas law when, as will occur here, the Class 1 Bonds are resold.

Doubt me?  Read section 2210.6136 of the Texas Insurance Code.

Sec. 2210.6136.  ALTERNATIVE SOURCES OF PAYMENT. (a)  Notwithstanding any other provision of this chapter and subject to Subsection (b), on a finding by the commissioner that all or any portion of the total principal amount of Class 1 public securities authorized to be issued under Section 2210.072 cannot be issued, the commissioner, by rule or order, may cause the issuance of Class 2 public securities in a principal amount not to exceed the principal amount described by Section 2210.073(b).


How those Class 2 bonds are to be repaid is set forth in section (b) of the same statute.

(b)  The commissioner shall order the repayment of the cost of Class 2 public securities issued in the manner described by Subsection (a) as follows:

(1)  in the manner described by Section 2210.612(a), in an amount equal to the lesser of:

(A)  $500 million; or

(B)  that portion of the total principal amount of Class 1 public securities authorized to be issued under Section 2210.072 that cannot be issued, plus any costs associated with that portion; and

(2)  after payment under Subdivision (1), in the manner described by Sections 2210.613(a) and (b), in an amount equal to the difference between the principal amount of public securities issued under Subsection (a) and the amount repaid in the manner described by Subdivision (1), plus any costs associated with that amount.


Thus, the method is not the 70/30 split that would be used if the Class 1 bonds had been sold and set forth in section 2210.613 of the Texas insurance Code.  Instead, because the TWIA policyholders would not yet have been burdened as much as that section contemplated, the TWIA policyholders pay the first $500 million under section 2210.6136 and only then is the 70/30 split invoked on the remaining possible $500 million authorized in Class 2 securities. You can read more about this issue here and elsewhere in this blog.

And here, we can see the problem.  If the market won’t lend TWIA money for Class 1 securities because it does not trust in the ability of TWIA policyholders to repay, why would it lend TWIA money for functionally identical securities that just say “Class 2 on them”?  Thus, TWIA should not be counting on being able to sell Class 2 securities.  And certainly not on being able to sell more than $500 million. The turquoise area should just be labeled, just as Chairman John Smithee suggested in his warning letter of May 29, 2013, to Governor Perry:  “GAP.”

And the situation is worse. It’s why Chairman Smithee spoke of a $1 billion gap.  For not only should the turquoise area be labeled GAP.  But the gray area above it for Class 3 securities should also be labeled GAP.  Read section (c) of the (in)famous section 2210.6136.  It states:

(c)  If Class 2 public securities are issued in the manner authorized by this section, Class 3 public securities may be issued only after Class 2 public securities have been issued in the maximum amount authorized under Section 2210.073.

If the Class 2 Alternative securities described in sections (a) and (b) don’t sell in full, then the Class 3 securities can not be sold AT ALL.

Thus, the graphic in question misleads the legislature by falsely asserting that TWIA will be able to sell Class 2 securities backed by a different pool of money than in fact will be used and by failing to note that the ability sell Class 3 securities is contingent on being able to sell every dime of $1 billion in securities whose repayment source is one that market appears already to have rejected.

Kind of a serious problem, yes? Let us hope the legislature gets to the bottom of this at the hearing today and TWIA is forced to issue a corrected report.


Smithee’s urgent warning to Governor Perry

I’ve decided that Representative John Smithee’s letter of May 29, 2013, to Texas Governor Rick Perry is of sufficient importance that I should just simply reprint it right here. It contains an urgent warning that TWIA is likely to have a $1 billion gap and will not be able to pay claims promptly for even a low severity storm.  No links to click.  Just read it.

John Smithee warns Governor Perry that TWIA likely has a $1 billion gap and will not be able to pay claims promptly for even a low severity storm

John Smithee warns Governor Perry that TWIA likely has a $1 billion gap and will not be able to pay claims promptly for even a low severity storm

If you want to understand why John Smithee is saying this, read entries in this blog such as this one and this one.

House Insurance Committee to hold special hearing today on TWIA finances

The House Insurance Committee will meet this morning (June 17, 2013) to “hear invited testimony relating to the current financial condition of the Texas Windstorm Insurance Association.” Here’s the link you need to watch the hearing live.

The decision to hold a special hearing comes in the wake of the decision of Texas Governor Rick Perry not to add windstorm reform to the agenda of the special session and the failure of the legislature to pass any significant legislation reforming the finances of the troubled windstorm insurer.  We have now learned that House Insurance Committee Chairman, Rep. John Smithee, had added his name to a plea to Governor Perry to add windstorm insurance reform to the agenda.  In a letter of May 29, 2013, and published here (for the first time, I believe), he said that what he regarded as a “prudent and sound decision” by outgoing Texas Insurance Commissioner Eleanor Kitzman to disapprove $500 million in loans via a Bond Anticipation Note (BAN) to TWIA “raises significant concerns regarding TWIA” and presented a $1 billion gap in TWIA’s finance structure.” Smithee further wrote:

“Without availability of the $500 million BAN, there appears to be a legitimate concern regarding TWIA’s liquidity to pay losses in the 30-90 days following a 2013 storm of even low to moderate severity.”


As this blog has indicated on many occasions, the problem, however, goes even beyond liquidity.  As will likely be discussed at today’s hearing, there is a serious question as to whether TWIA, under the current finance structure, will in fact ever be able to get significantly more than the piddly amount of cash it now has on hand in order to pay claims following a storm of moderate severity.

Here’s a copy of the full Smithee letter. It is the most stark assessment to date by a legislator of the serious problem facing Texas.

Smithee Governor TWIA call


Minor TWIA Bill Might Make It Through This Session

A bill making minor changes to the exposure of the Texas Windstorm Insurance Association passed the Texas House yesterday 134-11.  Before S.B. 1702 can become law, however, it will need to be reconciled in the closing days of the session with the substantially different version that passed the Senate last month.  Following amendments from Representatives Craig Eiland (Galveston) and John Smithee (Amarillo), the House version of the bill takes two actions with respect to Texas coastal building codes and insurance.  One of the provisions might increase TWIA’s claims in a tropical cyclone. The other might reduce it.

S.B. 1702 as amended in the House on motion of outgoing Galveston Representative Craig Eiland extends the time some coastal property owners with property that does not comply fully with building code standards a reprieve from somewhat tougher building standards until 2015.  Thus, for two more years during which TWIA’s reserves, even measured in the most optimistic way, are inadequate to pay for large storms, the House has apparently voted to actually increase TWIA’s exposure to risk.  This increase in exposure occurs because the premium surcharges on the these high risk properties are limited by the combinations of sections 2210.260(f) and 2210.259(a) of the Texas Insurance Code to 15%.  This value is likely insufficient to match the additional risk posed by these non-compliant properties.

A second provision of S.B. 1702 as amended in the House, however, one added by House Insurance Committee Chair John Smithee of Amarillo, might have a counterbalancing effect on TWIA exposure. It would condition eligibility for TWIA insurance after 2015 for homes and other property with values over $250,000 on compliance with stricter TWIA building standards. “Alternative certification” would not be available. There is no estimate that I have seen of the number or value of such properties that are currently insured by TWIA but out of compliance.

Based on my reading of the House Journal (pp. 3830-31), here’s the House version of the statute.

SECTION____.  Section 2210.260(d), Insurance Code, is amended to read as follows: (d)  Except as provided by Sections 2210.251(d), (e), and (f), a person who has an insurable interest in a residential structure that is insured by the association as of August 31, 2012, but for which the person has not obtained a certificate of compliance under Section 2210.251(g), must obtain an alternative certification under this section before the association, on or after August 31,  2015, may renew coverage for the structure.


SECTION ____. Subchapter F, Chapter 2210, Insurance Code, is amendedby adding Section 2210.2581 to read as follows:   Sec. 2210.2581. MANDATORY COMPLIANCE WITH BUILDING STANDARDS; CERTAIN STRUCTURES. Notwithstanding Section 2210.251, Section 2210.258, or any other provision of this chapter, after December 31, 2015, the association may not issue or renew insurance coverage under this chapter for a structure with an insurable value of $250,000 or more unless the structure complies with the applicable building code standards, as set forth in the plan of operation.

Although this bill may have some effect on individual TWIA policyholders, it is unlikely to have any significant effect on the ability of TWIA to pay claims following a major storm.  Absent a special session of the Texas legislature, it now looks as if that issue will need to await the 84th legislature two years hence in order to be addressed.  And whether S.B. 1702 passes or not, coastal Texas property holders will be at serious risk in the interim.

Texas Insurance Commissioner Eleanor Kitzman Confirmation in Doubt

Eleanor Kitzman

Eleanor Kitzman

Serious doubt exists today as to whether Texas Insurance Commissioner Eleanor Kitzman will be confirmed by the Texas Senate.  Her name does not appear on the list of nominees set for confirmation today and today appears to be the last day on which this committee will meet.  If so, and if, as I suspect, this is a response to her actions regarding windstorm insurance in Texas, this is a major loss for Texas. I would urge the legislature to reverse course. I would urge Governor Rick Perry and other leaders to speak up and support their choice.

But before voting to confirm someone with years of experience in insurance regulation and regarded highly enough nationally to head the critical Financial Regulations Standards and Accreditation Committee of the National Association of Insurance Commissioners (NAIC), legislators should at least examine the alleged marks against her.

The Rap Sheet

Count 1: Aggravated truth Telling

On or about June of 2012, Commissioner Eleanor Kitzman responded to a request from state Rep. John Smithee, R-Amarillo, by stating that the Texas Windstorm Insurance Association would be unable to pay claims fully if some Category 4 or higher hurricanes hit. This utterance challenged the prevailing wisdom that everything was fine with TWIA. It challenged the cultivated illusion that investors could regard collateral or property insured by TWIA as having the same degree of security as property and collateral insured by other Texas insurers. It threatened growth on the coast.

For this heresy, Commissioner Kitzman was welcomed back to Texas by Representative J.M. Lozano, R-Kingsville, with a request that she be investigated byTexas Attorney General Greg Abbott for breaking Texas law. And what law might it be that criminalizes speaking the truth? Lozano said her letter may have made a “misleading representation regarding the financial condition of an insurer” or somehow violated a state pledge not to impair collection of assessments on bonds that TWIA might issue following a major hurricane. Needless to say, the investigation requested by Representative Lozano, if one was ever done by our more level headed attorney general, went absolutely nowhere because Kitzman’s speech had violated no law and done no wrong.

Commissioner Kitzman compounded this alleged wrongdoing by then saying in her response to Chairman Smithee that, if TWIA did become insolvent, the state of Texas was under no legal obligation to make up for the resulting unpaid claims of TWIA policyholders.  Never mind the fact that absolutely no one has cited any legal authority saying that Texas has an obligation to pay such debts any more than obligations to guarantee other unpaid obligations throughout the state.  Never mind the fact that the Texas Property and Casualty Insurance Guaranty Association statute makes clear that it does not provide protection — at all — for government-created insurers. Never mind that Commissioner Kitzman is an experienced attorney and expert in insurance regulation who can read as well as anyone else and find no law creating such an obligation on the part of the State of Texas. Never mind, even, when I tell you as a professor of insurance law at a respected university that there is no such legal obligation. Commissioner Kitzman again disrupted the illusion that it was no more risky to invest on the coast of Texas than it might be to invest in El Paso or Dallas or San Antonio. And that, in certain parts of Texas, is apparently a crime or, if not, the basis for refusing to confirm an otherwise eminently qualified individual for a critical regulatory post.

But, of course, it goes beyond daring to question the assumption of security along the Texas coast or doing so just one time.

Count 2: Threatening A Trial Lawyer with reduction of fees

On or about March of 2013, Commissioner Kitzman asked the TWIA board to consider placing TWIA in receivership, the Texas equivalent of bankruptcy, following its filing of an annual report that showed that it was insolvent. Let us make clear what the consequences of such an act might be.

TWIA has been a boon to trial lawyers along the Gulf Coast.  In part because of extremely dubious adjusting practices by the Windstorm Association and, perhaps in part for other reasons, attorneys along the Texas coast have made hundreds of millions of dollars on contingency fees arising out of breach of contract, bad faith and statutory claims  against TWIA.  I am not, please note, saying there is anything wrong with this. Insurers do on occasion misbehave, perhaps particularly so, when they have not been properly capitalized. There need to be deterrents against exploitation of policyholders and there is nothing wrong with lawyers advocating zealously on behalf of their clients. And, in the interests of full disclosure, I worked at one time as an expert on behalf of one of those very plaintiffs firms evaluating what appeared to me to be inappropriate use of statistical evidence by TWIA in adjusting claims.

The key point, however, is that there are still a number of Ike claims pending.  In receivership, those claims might not be paid in full. They would have to be treated with at least some regard to future claims against an insolvent insurer. But, if those claims were not paid in full, not only would the claimants perhaps not receive perfect justice but the attorneys representing those claimants would likely suffer a commensurate reduction in their percentage interests (contingency fees) in the lawsuits. Both of those possibilities — a threat to people one has come to care about and a loss to one’s own pocketbook in the process — can make good people mad. And when those people also make hefty contributions to political campaigns, that’s almost a crime in Texas.

Moreover, consider the threat to the illusion of security compounded by going public with the idea that TWIA was insolvent, that future claimants might need to be treated fairly, and that TWIA might need to be placed into receivership.  Other Commissioners might have swept that issue under the rug or concocted ways to extract more money out of inland Texans to pay for future claims.  But not Commissioner Kitzman. By even uttering the word “receivership,” she compounded her earlier threat to the cultivated illusion of security that has fueled the addiction to continued development along the vulnerable Texas coast. Never mind that receivership might actually help TWIA recapitalize itself — indeed that is a major purpose of receivership — the public confirmation of TWIA’s desperate straits might make other lenders reluctant to lend and developers reluctant to develop on the strength of a TWIA policy.

Plea for Relief

There are, of course, other issues with Commissioner Kitzman’s tenure. Her views on balance billing rules in health insurance have stirred up controversy. And, because to my knowledge no public hearings were ever held on her appointment, we don’t know if there are issues pertaining to managerial competence or other matters. This is not a full accounting of her pros and cons.

From what I can see, however, Commissioner Kitzman has been an open and fair individual — yes one with a free market bent that one would have thought might have sold well in Texas.  She participated in creative efforts that did not constitute toadying to powerful private insurers to deconcentrate the risk now held in TWIA and get those insurers to start shouldering some of the windstorm risk but at fair prices. She’s presided over the growth in an outstanding web site that provides excellent information to consumers. She has been generous with her time to me, appearing in my insurance law class this fall to speak forthrightly with students. She’s been a leading figure nationally in insurance regulation.

I hope the Texas Senate somehow changes course and confirms her.  If not, I hope Governor Rick Perry figures out a way the State of Texas can continue to benefit from her expertise.  And, above all, I hope that legislators realize that shooting the messenger does nothing to protect the Texas coast or attract talent to critical fields in our state.


Smithee bill would require TWIA to tell policyholders the truth about its solvency

John Smithee photo

John Smithee

State Representative John Smithee (R-Amarillo) has filed a bill in the state legislature  (HB 2785) that would require the Texas Windstorm Insurance Association (TWIA) to tell its policyholders on the declarations page of any policy it sells after January 1, 2014, about the limited resources available to pay claims in the event of a serious storm. The bill requires disclosure of the financial resources of TWIA, including the state of its catastrophic reserve fund and the marketability of bonds on which TWIA currently relies to pay claims for even modest tropical cyclones.  Critically, it also requires a prominent warning to policyholders right on the declarations page of the policy that the state of Texas is not obligated to come to their or TWIA’s rescue in the event that TWIA can not pay.

Needless to say, Catrisk is enthusiastic about this bill for several reasons.  First, it will enable potential insureds along the Texas coast to make intelligent decisions about the extent to which they want to try to obtain non-TWIA policies to protect them in the event of a serious storm even if those policies are more expensive.  As it stands, some TWIA policyholders may suffer from the incorrect assumption that the resources available to pay claims from policies purchased from TWIA, which currently relies on a paltry catastrophe reserve fund and a shaky structure of post-event bonds, are the same as those available from regulated private insurers, who would be put out of business if their reserves were anything near the inadequacy of TWIA’s. The misinformation suppresses demand for policies from regulated insurers and thus contributes to the self-fulfilling prophesy that the regulated market “can not do business on the coast.” Other prospective insureds, by the way, may actually have an exaggerated sense of TWIA’s instability and thus decline to purchase TWIA policies due to excessive fear. The bill, by providing the relevant facts, could help both groups of people make an informed choice.

Second, those contemplating migration or business expansion on the Texas coast will now be advised to think about whether they want to choose between going with a less expensive but flimsy insurer (TWIA), scrounging for difficult-to-obtain and often expensive wind insurance from a private insurer, or deciding that there may be better places in which to invest. This, of course, is precisely why some coastal interests, particularly those who benefit from immediate investment on the coast, oppose bills such as HR 2785. Telling people the truth about a risky product is indeed likely to drive down demand for the risky product while stimulating demand for the safer.  But getting demand for insurance products back to fair market levels, as opposed to levels inflated by subsidization and misinformation, is a good thing for Texas as a whole. Market distortion is not a zero sum game.

Third, this bill is a good idea regardless of the form in which TWIA goes forward.  Whether TWIA is transitioned out for residential policies, as proposed in the recent Carona bill, or strengthened through significant subsidies, as in the recent Hinojosa and Hunter bills, many policyholders are likely to remain in TWIA or potentially in TWIA for several years to come.  In that interim period, those policyholders should be warned of the remaining dangers posed during the transition to a system of greater solvency.  The faster and more forcefully that transition occurs, the less dire the warnings will need to be.  I am confident that Representative Smithee would be glad to include an amendment to his bill exempting TWIA from the disclosure requirements if it could show the Texas Insurance Commissioner that it would satisfy solvency requirements imposed on other Texas insurers.

At least one coastal legislator, Todd Hunter of Corpus Christi, has voiced opposition to the Smithee bill.  He did so at a hearing last year (go to go to 1:57:50 to 2:02:18 of the recording) in cross examining me about ideas similar to those found in the Smithee bill.  And he is reported today in a Corpus Christi Caller article as asking, “Why should coastal residents be the only people subject to this Miranda warning from (the association)?” Hunter asked. “Why is it not required, statewide, for all carriers?”

The rejoinder to Representative Hunter’s opposition, however, is that other Texas carriers are subject to financial solvency regulations from which TWIA is exempt and as to which TWIA would be in serious violation were it ever required to follow them. The reason TWIA policies should be stamped with bold red warning labels is the same reason that we stamp surplus lines policies in Texas with similar warnings: they are not subject to the same regulatory structure that works pretty darned well in preventing insurer insolvencies. Coastal residents are mature enough to handle the truth. Just because TWIA and State Farm both have the word “insurance” in their names does not mean that the law should treat them the same.  We don’t exempt investments in junk bonds from disclosure regulations about the risks involved just because some other forms of “investment”, such as certificates of deposit in a federally insured bank,  are not subject to as strict disclosure rules.  And, again, if equality of treatment is really the objection of some coastal legislators, an amendment exempting TWIA from disclosure in the event its financial condition would satisfy otherwise applicable solvency regulations seems a better answer than keeping TWIA policyholders in the dark under the fiction of “equal treatment.”

Note 1. The Smithee bill closely follows Recommendation #10 posted on this blog on September 10, 2012.  In “Ten fixes for TWIA: What I’m planning to say in Austin this week” I wrote as follows.

10. Require prominent disclosure to TWIA policyholders created by the financing structure in place (as modified by the reforms suggested here or otherwise enacted). This disclosure should, at a minimum, advise policyholders of the approximate probability, computed using the best historical data and contemporary models, of the risk that TWIA will become insolvent, will be impelled to increase premiums to pay off Class 1 securities and will be impelled to impose surcharges to pay off Class 2 securities. Disclosure should be made (a) on a document signed by applicants for TWIA policies (new or renewal); (b) stamped (similar to surplus lines stamping) on policies issued by TWIA; and (c) on a web site one or fewer clicks from the main TWIA page.


Note 2. The bill also echoes thoughts expressed in this blog here:

Policyholders don’t need to be scared about every unlikely event, but they have a right as adults to know of a substantial risk.  Losing your house and facing an insolvent insurer qualifies. We warn holders of surplus lines policies of lesser protections against insurer insolvency with a great big stamp on the policy.  Why not the same for an equally unguaranteed and often far riskier insurer. And while we’re warning, let’s also warn them of the potential for post-event Class 1 assessments, for which the risk is yet far higher and uniform throughout the TWIA territory.

Note 3. Although I suspect many insurance agents will not immediately embrace the Smithee bill, enlightened ones should do so.  This is because the bill should provide some protection to insurance agents who now find themselves in a difficult position.  Right now, insurance agents who don’t warn their policyholders of TWIA risks may be setting themselves up for a lawsuit.  The dangers of TWIA are so palpable that a plausible claim of negligence or intentional non-disclosure is definitely something these agents need to be concerned about in the event TWIA either can not play claims or is highly delayed in paying claims.  It is wishful thinking and ostrich-like behavior to pretend this serious risk does not exist. On the other hand, insurance agents who do warn their policyholders of TWIA risks may find business going elsewhere. The bill probably saves agents the dilemma of whether or not to tell the truth by leaving disclosure to the policy itself.